When a downstream producer enters backward into the input market, a “helping the rivals” effect exists: such entry hurts the firm’s downstream business as it increases upstream competition and thus reduces the input price for rival downstream firms. This negative externality prevents the newly-created upstream unit from expanding. A spin-off enables the firm to credibly expand in the input market, forcing the upstream competitors to behave less aggressively, a task direct entry could not accomplish. The firm chooses not to spin-off (and remain self-sufficient) if the number of downstream firms, n, is small; a complete spin-off if n is large; and a partial spin-off if n is in the intermediate range. Spin-offs can lower welfare by worsening the double-marginalization problem.
Lin, P. (2001). Strategic spin-offs (CPPS Working Paper Series No.110). Retrieved from Lingnan University website: http://commons.ln.edu.hk/cppswp/57/